Educational Articles

Using the Value Line Page: Is Travelers a Good Buy Now – December 17, 2010

Reuben Gregg Brewer
| December 17, 2010

There are vast array of investment styles to follow when selecting stocks. One is to focus only on the largest, most successful companies. The Travelers Companies (TRV – Free Analyst Stock Report) is one such company. Not only is it in the Dow 30, an obviously select group, but it is also one of the leaders in the property/casualty insurance industry. In fact, with a market capitalization of about $25 billion (as noted in the Capital Structure box), it is a market behemoth even beyond its own industry.

Being large alone, however, doesn’t make a company an industry leader. As Value Line analyst Alan House highlights in the Analyst Comment, though, Travelers’ strength goes well beyond its size and broad product scope. Earnings were up materially in the third quarter, handily beating our estimate. In addition, the company’s combined ratio was below one—meaning it made money on the policies it sold. (The combined ratio is the percentage of losses to premiums earned plus the percentage of expenses to premiums written. The break-even point is 100%; in other words, a combined ratio of less than 100% represents an underwriting profit and a combined ratio of more than 100% represents an underwriting loss.)

Although making money on the product one sells would seem a necessary function of staying in business, the insurance industry doesn’t always achieve this goal. In fact, some companies intentionally sell policies at a loss so that they can attempt to make money by investing the premiums they receive. Travelers has had a strong run of solid underwriting results, earning a good return on its policies since 2006, as can be seen in the Underwriting Margin line of the Statistical Array. This, however, followed a string of five years in which the company lost money on the policies it wrote. That period began in 2001 and large insurance payout events, including the September 11, 2001 terrorist attacks and Hurricane Katrina in 2005.

These types of natural and unnatural disasters can play an important part in an insurance company’s profitability. Of late, though, there have been few catastrophes, so most insurers have benefited on this side of the equation. That said, the recent recession and listless economic recovery since then haven’t been kind to the industry, as some insurers have had a hard time attracting new business and retaining old customers. Travelers, however, has been performing well on both accounts. Although some of that success is attributable to the company’s size, its strong operations shouldn’t go unnoticed. Noting that underlying strength, and taking into consideration the company’s continued share buybacks, Alan House upped Value Line’s 2011 earnings estimate for the company. (Note that the historical portion of the Statistical Array clearly shows the aggressive share buybacks that have taken place since the share count peaked in 2005 at almost 700 million.)

In addition, the shares have a conservative profile, as noted by the good rank for Safety (2) and beta of 0.85 (a beta of less than 1.00 means the shares’ fluctuations tend to be less severe than those of the broader market). Both of these measures can be found in the Ranks box at the top left of each Value Line report.

So, if one is simply looking for an industry leader, Travelers is clearly a company worth considering. However, industry leader status alone doesn’t necessarily make a company’s stock a good investment. Taking a deeper look at the company’s valuation suggests that the market has recognized the company’s strength and rewarded it with a relatively rich price.

For example, the company’s P/E of 8.3 is just half that of the broader market (known as the Relative P/E), as noted in the Top Label that runs across the top of each report. Neither the actual P/E nor the Relative P/E is out of line with the company’s historical levels for these metrics, as seen in the Statistical Array. This in an industry that has generally underperformed, making Travelers’ valuation level a premium relative to the industry as a whole. In fact, House believes that other companies in the industry might provide for more upside potential without investors taking on an undue level of additional risk.

So while conservative accounts might be well served by investing in Travelers, those with a modest amount of risk tolerance should probably broaden their search.

At the time of this article's writing, the author did not have positions in any of the companies mentioned.